Over the past month or so LINN Energy (NASDAQOTH:LINEQ) has been under a bit of an attack from short sellers. The company has been quick to respond to these comments and its most recent response (link opens a PDF) had a very detailed analysis of its net asset value. It's always a good idea to have at least some basis for what an investment is worth, so let's drill down into LINN's net asset value.
LINN's recent presentation provided investors with two different analyses of its net asset value. One is the company's internal analysis and the other came from a third-party advisor. Both showed that LINN is currently undervalued, and possibly has an upside of up to 70% even before taking the company's recently announced Berry Petroleum (UNKNOWN:BRY.DL2) merger into account. Let's take a look at what this all means to current and potential LINN Energy investors.
LINN's own internal analysis implies an equity value of $44.74-$64.74 per unit. The foundation of its analysis is its proved reserves, which when you add it all up, gives a base value of $8.8 billion. These reserves include both proved developed and unproved developed which are believed to hold approximately 5 trillion cubic feet of equivalent, or Tcfe, of reserves.
One thing I will point out is that in LINN's valuation it is using a PV-7.5 instead of a more traditional PV-10 value. What it's doing is taking the present value of these reserves and not discounting it as deeply. Given LINN's low cost of capital, and the fact that these are known reserves, it's not using an overly aggressive rate but it is something an investor needs to know.
In addition to the reserves that LINN has in place, it owns a gas processing plant that it acquired from BP (NYSE:BP) in the Hugoton deal last year. At the time the plant was just 41% utilized giving it significant excess capacity and future upside. LINN has value in its hedge book as well as additional assets and facilities that hold value. Together, these assets add another $1.3 billion in value to the company.
From here the value gets a little more complicated and is more open for debate. LINN has a significant inventory of future drilling sites which could possibly yield upwards of 14 Tcfe of reserves. A large portion of this future potential is located in its Granite Wash acreage which could deliver 5.2 Tcfe of future production, however, in order for that production to be realized, gas needs to move above $4.70 per MMBtu after 2018 and oil needs to remain above $90 per barrel.
When you incorporate this future potential it adds significantly to LINN's net asset value. Using both PV-15 and PV-10 rates these reserves could add between $6.5 billion and $11.2 billion to the company's value respectively. Taking that top number, and netting out its debt, it implies a value upwards of $65 per unit.
LINN's third-party advisor's analysis isn't quite as high as is LINN's internal analysis. The third-party came up with a value of $37.34-$51.15 a unit. The difference here is that its valuation factors in current forward strip pricing as opposed to LINN's assumption of higher gas prices by 2018. When you consider the volatility in the price of gas, caution isn't a bad idea.
Given that valuations are more art than science, the key takeaway here is that there is the potential for substantial future value to be realized at LINN Energy. That's on a baseline that assumes that the company never makes another acquisition. I think it's safe to say that LINN won't stop acquiring assets anytime soon, which could add significant future value. This is the company that spent more than $2.2 billion raiding BP for assets last year and along with its affiliate LinnCo (UNKNOWN:LNCO.DL) has already announced the $4.3 billion Berry Petroleum deal.
At worst, LINN is probably fairly valued in the mid- to upper-$30 range per unit. Depending on how optimistic you want to be, the upside from there could be substantial. One thing is sure, you can feel fairly confident that an investment in LINN should provide an annual return that's above its current distribution of 7.7%.